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Corporate earnings show a high degree of resilience amid rising rates—can it last?

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKET PERSPECTIVES — October 31, 2022

 

With October nearly a wrap, the S&P 500 Index is up +8.8% heading into Halloween. While the Index is having its strongest month since July, and when stocks experienced a similar bear market rally following oversold conditions in June, it’s the Dow that’s catching all the buzz this month. The Dow Jones Industrials Average is higher by an eye-popping +14.4% in October and on pace for its best October in history and set for its best month since January 1976. Other than January 1976, the Dow hasn’t seen this strong of a month since the 1930s. Value stocks have gone on a tear, with the S&P 500 Value Index outperforming the S&P 500 Growth Index by nearly 630 basis points in October.

The attraction to old economy stocks has intensified as of late, which tend to be less sensitive to interest rates and exhibit more stable growth/profitability trends during times of heightened uncertainty. And though the NASDAQ Composite is up nearly +5.0% in October, there has been a pronounced shift in the types of stocks leading the current bear market rally versus the stocks that led the market out of the June lows.

Last week, the S&P 500 Index rose nearly +4.0%, with U.S. equities broadly higher for the second consecutive week. The NASDAQ rose +2.3% and appeared to weather a series of disappointing Big Tech earnings that had the potential to derail the current bear market rally. On the Big Tech front, Meta was down roughly 24% on the week after missing operating profit expectations and warning of higher operating expenses. Amazon fell over 13% as Q3 revenue, and operating income came in light of expectations while warning that Q4 profits would be much weaker than forecast. Alphabet slid 4.8% last week, logging a significant earnings per share miss amid a broader slowdown in advertising, while Microsoft dropped 2.6% on lower guidance and currency headwinds. However, Apple’s earnings results were greeted more favorably, with the stock moving higher by +5.8% on the week, though iPhone results for the previous quarter were only in line with expectations.

Big Tech likely to feel the pinch amid the current environment; Now is the time to be selective with stocks

Bottom line: The profit results from Big Tech last week show the stock market’s largest companies, with the strongest secular drivers on the planet, are not immune from a broader economic slowdown or ongoing macro issues such as currency and supply chain constraints. In our view, a slowdown in spending across consumers and businesses over the coming quarters is likely to pinch Big Tech results. For investors, the $64,000 question is how to value some of these companies against a backdrop of higher interest rates and, in some cases, slowing growth trends unlikely to reclaim levels seen when these companies were smaller and more agile. Our current sector allocations take some of these factors into account. For example, we are tactically underweight Communication Services and Consumer Discretionary, as Meta, Alphabet, and Amazon carry heavy influences across these sectors. Conversely, we are overweight Information Technology, where Apple and Microsoft have outsized weightings, and we believe bring more visible and stable profit trends to the investment equation.

Notably, quality companies can be found across sectors today. Nevertheless, this is the time to be selective when looking at stocks. Focus on stability, predictability, and patience, particularly when seeking longer-term opportunities that often form in bear markets. A strong batch of earnings releases last week from value-based companies, including across Healthcare and Consumer Staples (two sectors we are currently overweight), also highlight that Value may remain in vogue as long as uncertainty remains elevated and investors crave stability.

Earnings appear strong, but companies warn of headwinds and uncertainty

With 52% of Q3’22 S&P 500 profit reports complete as of last Friday, blended earnings per share (EPS) is higher by +2.2% year-over-year on sales growth of +9.3%. Thus far, 71% of companies reporting results have beaten EPS expectations, while 68% have surpassed revenue guidance. However, both measures are below the one-year and five-year averages. Corporate commentary remains cautious. Companies have pointed to high uncertainty, currency headwinds, lingering supply chain constraints, inflation pressures, and concerns about consumer trends. However, commentary around the current state of the consumer has pointed to a high degree of resiliency to this point, which has helped fuel better stock momentum during the earnings season. Over the coming week, 167 S&P 500 companies will report their Q3’22 results, including one Dow 30 component.

Outside of equities, U.S. Treasury prices were firmer on the week, as the 10-year Treasury yield fell back below 4.00% after touching 4.30% at one point. The U.S. Dollar Index posted modest gains last week, Gold dropped 0.7%, and West Texas Intermediate (WTI) crude settled higher by +3.4%.

GDP surprised to the upside as the economy shows signs of resilience against Fed Policy; investors prepare for another rate increase from the Fed

In other highlights from last week, the first look at Q3 GDP showed the U.S. economy grew by a surprisingly strong +2.6% quarter-over-quarter annualized. Increased exports, nonresidential fixed investment, government spending, and consumer spending helped drive stronger-than-expected growth in the previous quarter. In our view, the most significant takeaway from the Q3 GDP report is how a resilient economy impacts Federal Reserve policy and any potential for a pivot or slowdown in rate increases over the coming months. Our GDP estimates suggest the economy is likely to cool in the fourth quarter and into next year. Notably, consumer sentiment declined more than expected this month, and preliminary looks at October manufacturing and services activity shows each sits in a contraction. Lastly, on the week, September durable-goods orders missed expectations, September pending home sales registered a 10% monthly decline amid higher mortgage rates, and the Bank of Canada and European Central Bank lifted interest rates to help slow inflation in their economies.

In addition to one of the busiest weeks of the earnings season, investors will be barraged with a host of economic data and policy decisions this week that could influence stock prices through year-end. One of the key areas of focus this week will fall squarely on Wednesday’s Federal Open Market Committee (FOMC) policy decision. The Federal Reserve is widely expected to lift its fed funds target rate by another 75 basis points in an effort to further constrict growth and tame inflation. Investors will look to parse through the policy statement as well as Fed Chair Jerome Powell’s comments after the policy decision for clues on where rates are headed next.

Investors should prepare for the Fed to continue hiking rates; All eyes will be on Friday’s Jobs Report

Importantly, markets could walk away from this week’s Fed decision somewhat disappointed if there is not a clear message the Fed intends to slow rate hikes at the December meeting. In our view, Fed officials will likely want to give themselves the most flexibility to raise rates aggressively in December (if needed) should inflation remain stubbornly stuck at elevated levels. While a Fed pivot may be music to the market’s ears, investors should be careful not to be lulled into a siren song.

Also on tap this week, October ISM manufacturing and services data should show a moderation in activity, though both measures are expected to remain in an expansionary condition. However, manufacturing activity is seen falling to a two-year low. And for the services component of the economy, producer sentiment has consistently fallen each month from its peak in November 2021. October vehicle sales and the September Job Openings and Labor Turnover Survey (JOLTS) report will also receive some attention this week.

But a busy week of earnings, economic data, and a closely watched Fed policy decision point to Friday’s all-important October nonfarm payrolls report. FactSet estimates are looking for +195,000 new jobs in October, down from the +263,000 jobs created in September, the +315,000 in August, and the +537,000 pace seen in July. The unemployment rate is expected to tick up to 3.6% in October from 3.5% in September. In our view, employment growth should continue to moderate in the months ahead as rates climb higher and economic activity slows. Although the employment report tends to be a lagging indicator for the health of the economy, a strong job market has been one of the few bright spots investors have been able to point to this year in an otherwise stormy environment. We suspect ongoing strength in the labor market could produce mixed messages for investors regarding rate policy, yet, we believe few want to see an outright downturn in employment.

Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.

Some of the opinions, conclusions and forward-looking statements are based on an analysis of information compiled from third-party sources.  This information has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. It is given for informational purposes only and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the specific needs of an individual investor.

Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.

Value securities may be unprofitable if the market fails to recognize their intrinsic worth or the portfolio manager misgauged that worth.

The fund’s investments may not keep pace with inflation, which may result in losses.

A rise in interest rates may result in a price decline of fixed-income instruments held by the fund, negatively impacting its performance and NAV. Falling rates may result in the fund investing in lower yielding debt instruments, lowering the fund’s income and yield. These risks may be heightened for longer maturity and duration securities.

The products of technology companies may be subject to severe competition and rapid obsolescence, and their stocks may be subject to greater price fluctuations.

Past performance is not a guarantee of future results.

An index is a statistical composite that is not managed. It is not possible to invest directly in an index.

The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees.  It is not possible to invest directly in an index.

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The Institute for Supply Management (ISM) manufacturing index is a national manufacturing index based on a survey of purchasing executives at roughly 300 industrial companies. It is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

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